Is your farm downturn-ready?
You're likely not going to make as much money next year as you have the last couple of years. That's what all the experts are saying. But, amidst all that talk, have you prepared your farm for the coming downturn everybody's talking about?
It's probably far from what you really want to do this time of year, but getting everything organized, namely financial documentation, will serve you well if and when that downturn unfolds into a lower income situation for you in 2014.
"Is your operation prepared for tighter margins ahead? You likely complete annual maintenance on your equipment or routine vet checks for your livestock; do you complete a ﬁnancial checkup for your operation?" says Iowa State University Extension farm business management specialist Kristen Schulte. "With changing prices and margins from year-to-year, a closer look at your ﬁnancial position may be important for long-term ﬁnancial stability."
So, what can you do? Start with the paperwork, namely 3 key documents: Your balance sheet, income statement and cash flow statement, all of which will comprise your ultimate farm financial position moving forward. A comprehensive income statement is important for tax purposes, but at times like this when a change in income potential is expected, you'll want to go further than what the IRS will require in a few weeks.
"Although a Schedule F may be completed for tax returns, additional steps need to be taken to complete an income statement. Most farms only complete ﬁnancial statements on a cash basis; to get an accurate picture of the operation’s ﬁnancial success in the current year, an accrual adjusted income statement should be completed," Schulte says. "Research has shown that accrual basis statements can reveal an operation under ﬁnancial stress sooner than when using cash basis statements."
Cash flow may not be as important to the long-term sustainability of your farm, but it's critical to weathering a looming downturn, Schulte says.
"This statement can be done on a monthly, bi-monthly, or quarterly basis. A completed cash ﬂow will give an operator insight into if the operation can meet all cash needs or when the operation will need operating funds due to cash deﬁcits," she says. "In the coming year with the forecast of tighter margins, a cash ﬂow statement will become more important to determine the ﬁnancial strength of an operation and its ability to meet ﬁnancial obligations."
Once you have all this data compiled and organized, step further and look at potential income scenarios. What's the difference between the impact of a 5% decline in income and a 10% decline? Answering questions like that can help you go further in deciding what you should do to prepare for any downturn that may unfold in the coming months.
"Production agriculture today is extremely volatile; sensitivity analysis should also be completed to evaluate the ﬁnancial stability of the operation. Examples of changes to measure sensitivity are an increase in expenses, decrease in revenue or increase in interest rates. To measure sensitivity, one should shock revenue or expenses by 5% or 10% and interest by 3% or 6%," Schulte says. "Net farm income is then evaluated to see where the farm’s proﬁt level is after each change. More detailed analysis can include speciﬁcally shocking or changing commodity prices or input prices to evaluate the impact of speciﬁc factors. Can your operation sustain a decrease in revenue due to changes in prices or yields and to what degree?"